Liquidation Mechanisms and Price Impacts in DeFi

Phoebe Tian and Yu Zhu

Staff Working Papers from Bank of Canada

Abstract: This paper examines the price impacts of liquidations in decentralized finance (DeFi) lending and how they vary with fixed-spread and auction-based liquidation mechanisms. Using a theoretical framework, we show that the impact of these mechanisms depends on the liquidator participation cost, which determines the level of competition. Auctions mitigate the price impact of liquidations when the participation cost is low, but amplify them when it is high. Empirical analysis of Ethereum blockchain data shows that auction-based liquidations lead to smaller price drops by increasing competition, which raises collateral prices and reduces liquidation volumes. These findings underscore the importance of liquidation design in promoting market stability and mitigating fire-sale risks in DeFi lending.

Keywords: Digital; currencies; and; fintech (search for similar items in EconPapers)
JEL-codes: D44 D47 G20 G33 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2025-03
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:25-12

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